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Source link: http://archive.mises.org/4932/newsflash-demand-curve-slopes-down/

Newsflash! Demand Curve Slopes Down!!

April 20, 2006 by

USA Today’s front page headline today really isn’t that far from mine: “Cutting back at the pump: Gas use drops as prices rise”. But USA Today writer James Healey’s economic insight doesn’t stop there… It looks like the supply curve slopes up!

Fuel conservation might be short-lived. For one thing, prices are likely to drop. EIA says, “Significant increases in gasoline production … over the next several weeks should stem the rise in gasoline prices and may, actually, cause them to decline somewhat.”

Let me be clear that I’m not complaining. Would that we regularly had headlines proclaiming economic truths. In fact, let me suggest some:

  • Prices move to match supply and demand!
  • Rent control causes housing shortage!
  • Regulatory paperwork burden favors large, established firms!
  • Minimum wage disemploys least skilled!
  • Federal Reserve causes inflation!

{ 11 comments }

W Baker April 20, 2006 at 11:24 am

One might add the inflation of oil prices caused by US foreign policy?

Gosh, is there any way the White House and Pentagon can hype up a threat somewhere in the Caucuses or Venezuela so that we top $150 a barrel?

Tom April 20, 2006 at 1:34 pm

Steve, I am afraid these are not economic truths, but rather bad economic thinking. Why is it bad economic thinking? Because the reporter and those quoted in the article cannot make a fundamental distinction between a change in the quantity of gasoline demanded and a change in demand for gasoline.
“Gas use last month was 0.6% less than a year ago, the American Petroleum Institute reported, because “high fuel prices have led to decreased demand for gasoline and other refined oil products.”"
This is incorrect. High fuel prices led to a decrease in the quantity of gasoline demanded, but not a decrease in the ‘demand for gasoline and other refined oil products’. A change in the price will lead to a movement along the demand curve, while change in demand shifts the entire demand curve. High fuel prices do not affect demand; it affects the quantity of gasoline demanded.

Next we have a suggestion to reduce the demand for gasoline (shift the demand curve to the left) by driving less:
“If everyone decided to drive 3% less the next 30 days, prices would crash,” says Tom Kloza, senior analyst at the Oil Price Information Service. ”
“Fuel conservation might be short-lived. For one thing, prices are likely to drop.”
Again, the article mixes a shift in demand (fuel conservation reducing demand), with a movement along the demand curve (lower prices increasing the quantity of demanded). A drop in the price of gas will not cause an increase in demand for gasoline, it is merely a movement along the demand curve. That is, fuel conservation moves the demand for gasoline to the left, a change in price will not move the demand for gasoline to the right. A change in price will be a movement along the fuel conservation demand schedule.

“History shows that as long as gasoline is available, at whatever price, Americans tend to adjust to the price and resume their previous driving habits. ”
The sentence suggests a vertical demand curve.

“Last time gasoline consumption dropped significantly was September, because of high prices and spot shortages caused by Hurricane Katrina’s damage to energy operations in the Gulf of Mexico. ”
“Demand continued to slide for a while after that, but it does so routinely in the fall and winter. So it’s difficult to separate Katrina-sparked conservation from seasonal patterns.”
Once again the article is mixing a change in the quantity demanded due to rising prices and a change in demand caused by consumers traveling less in the fall and winter months. This article is full of bad economic thinking.

Stephen W. Carson April 20, 2006 at 1:39 pm

Tom, your point is well taken. I thought about pointing these things out but thought it would be more fun to focus on the headline. When it comes to the mainstream media, I’ll take what I can get!

Vince Daliessio April 20, 2006 at 1:48 pm

As will I. The mainstream media seem to consist of people that think in completely contradictory ways, e.g.; “Gas prices are going up – government MUST step in!” AND; “People drive too much and burn too much gas – government MUST step in!”

Unfettered markets would perform these functions economically and automatically.

But, alas, they sell few newspapers.

Robert April 21, 2006 at 10:30 am

I thought Austrians emphasized subjectivism and expectations.

There’s so much oil in the world. Anybody that owns rights to some field has to make decisions about increased drilling now or later. A current rise in prices doesn’t necessarily lead to an increase in the current quantity supplied. It depends on expectations about, say, movements in future prices. (Another consideration might be expectations about future energy producing technology, some of which might result from Research and Development funding from other entrepreneurs reacting to their own expectations about future movements in prices.)

These kind of considerations about processes set in historical time don’t seem to me to be captured in the intro supply and demand story.

And I leave aside the unjustified minimum wage story, except I thought that Austrians were against abstractions that lose important concrete elements of economics. For example, the oil example involves stock and flow interactions that are not applicable to labor. Labor services are a flow. A flow of my particular kind of labor service is not traded off in time in the same way the services of oil are. And outside of a slave economy, one doesn’t own a stock of labor like one can own rights to an oil field.

billwald April 21, 2006 at 11:34 am

Supply and demand is only in effect in large cities where there is competition between retailers with the same brand of gas. There is no price competition in small towns – or at rural freeway interchanges.

Tom April 21, 2006 at 2:09 pm

“Supply and demand is only in effect in large cities where there is competition between retailers with the same brand of gas. There is no price competition in small towns – or at rural freeway interchanges.”

Does anyone really believe this? Besides the fact that it is total economic nonsense, big cities like Los Angeles and New York have very high gas prices.

billwald April 26, 2006 at 6:37 pm

Every gas station in NYC and L.A. has the same posted prices? I don’t think so.

Every national brand gas station in Leavenworth, WA, posts the same price. It is a tourist town. When the Safeway put in gas pumps and matched the lower gas prices in Wenatchee, a working man’s town 20 miles to the east, the rest also lowered their proces – until the major brand stations realized that tourists don’t buy gas at the Safeway. Their prices are now back to 10 cents higher than at Safeway or in Wenatchee.

Rupert September 19, 2006 at 8:02 am

Of course, the supply of energy is not operating in perfect competition, so the typical demand/ supply curve will not always apply. You might like the attached.

http://www.gasandoil.com/goc/speeches/mckillop.htm

Roger M September 19, 2006 at 8:57 am

The media has ignored the role of inflation in oil prices, too. Use any deflator and you’ll find that current oil prices are equal to those of the early 1980′s.

A couple other points on oil prices:

1) Austrians usually talk about long term trends. Most of the discussion about oil prices relate to the short term. In the short term, prices are set at the margin, not by the average consumer. The consumer has a minimum amount of gas he has to buy in order to go to work, take the kids to school and shop, and it’s fixed by his current car model. In the long run he can switch cars, but not in the short run. The same is true for trucking companies. So in the short run, prices are determined by those who trade oil and gasoline rapidly, that is, the speculators. Consumer demand affects prices only in the long run.

2) The oil industry is capital intensive. That forces them to be very slow to invest in new production because once they do, they’re married to it and have to produce even if the price just covers marginal costs. So about a 5 year lag exists between peak prices and peak production. Consumers shouldn’t expect a spike in oil to increase production next month. It won’t happen.

Björn Lundahl October 12, 2006 at 2:37 pm

People do not realize that gas, in a free market, does not suddenly run out.

Gas does not suddenly, in a free market run out. Prices today reflect “expectations” of the available supply and demand for goods and services “today and tomorrow”. If, for instance, the expectation is that oil supply will decrease or will be less than demand in ten years time, it will influence oil prices today. Prices today will go up. People will have the incentive to conserve (demand will decrease) and to develop new alternatives. Actually, we are probably conserving too much, because of OPEC and Governments taxations are keeping prices higher than they otherwise would be. “That oil soon runs out” is a political slogan that keeps coming up to keep politicians busy. This political slogan sounds true and will, therefore, “in the political market” sell. Only true markets can handle this sort of complex things. Compared to markets, Governments are too simple minded and primitive, because of the fact; they lack the essential tools that are needed to solve these kind of “problems”. They primitively, for example, regulate car manufacturers (and in the end consumers) to produce cars which improve gas mileage and impose upon people speed limits, without knowing if these actions are good or bad. Only markets can tell if conservations are good or bad, because market prices gives people the necessary signals of supply and demand, and people can therefore compare these prices to their own values if they are profitable or not to realize. The essential tools that are needed (which Governments are always lacking) are, as mentioned, “market forces and the market price mechanism”. Without these mechanisms nothing can be done. For example, a scientist will not reach the truth in trying to calculate physical available quantities and compare that to what he expects physical demand will be. It is silly, it is static and mechanistic. Every individual and every business around the whole world, with all the different knowledge, all the time, and in all possible situations, and which are directly influenced of higher prices, will conserve and try out alternatives. Even people and businesses that are not directly influenced of higher oil prices, also, have incentives to find out alternatives. These things happen all the time with all goods, services, capital and raw materials, and it run smoothly without us even noticing it. If Governments were going to replace the markets, we would probably end up with no available goods and services at all! In a sense, this would solve the “conservation problem” (joke). To make an example of this lack of knowledge and the belief that you can ignore markets, look at the so called “Club of Rome”, a group that made fools of themselves in the 70s with their book
“Limits to growth” (http://www.answers.com/the+club+of+rome?gwp=11&ver=2.0.0.453&method=3). If they were right, we would probably barely, even, live today!

Björn Lundahl
Göteborg Sweden

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